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DDi Corp. (NASDAQ:DDIC)

Q3 2008 Earnings Call Transcript

October 22, 2008 5:00 pm ET

Executives

Kathleen Buczko – NMC Partners

Mikel Williams – CEO

Sally Edwards – CFO

Analysts

Shawn Hannon – Needham & Company

Robert McNamara [ph] – Hudson Technology [ph]

Matt Riegner [ph] – Randac Funds [ph]

Shawn Harrison – Longbow Research

Michael Bertz – Kennedy Capital

Operator

Good day, ladies and gentlemen, and welcome to the quarter three 2008 DDi Corporation earnings conference call. My name is Michelle and I will be your operator for today. At this time all participants are in a listen-only mode. (Operator instructions) I would now like to turn the call over to Ms. Kathleen Buczko of NMC Partners. Please proceed ma’am.

Kathleen Buczko

Thank you, Michelle. Good afternoon, and welcome to DDi Corp’s third quarter 2008 earnings conference call. Presenting on behalf of the company will be Mikel Williams, DDi's Chief Executive Officer and Sally Edwards, the company's Chief Financial Officer. You are reminded that comments made on this call may include projections or other forward-looking statements regarding the future operations, opportunities or financial performance of DDi within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties such as that actual results and circumstances can different materially from those to be discussed.

Risks and uncertainties include but are not limited to business cycles that could impact demand for DDi's products and services, fluctuations in quarterly operating results because the company primarily sells pursuant to purchase orders rather than long-term contracts. Intense competitive pressures within the highly fragmented PCB industry and successfully complying with applicable environmental laws and regulations. Careful consideration should be given to DDi's cautionary statements made in public filings with the Securities and Exchange Commission including but not limited to the company’s most recent reports on Form 10-K, 10-Q, and 8-K.

The forward-looking statements made in today's conference call are based on information available as of today and DDi assumes no obligation to update such statements to reflect the events and circumstances after today's date. Additionally, please note that during this call management may discuss non-GAAP financial measures such as adjusted EBITDA.

For each non-GAAP financial measure discussed, a reconciliation of the differences between the non-GAAP financial measure and the most directly comparable GAAP financial measure is available on the company's website at www.ddiglobal.com as part of the company's earnings release for the third quarter 2008. With that I'll turn the call over to Mikel Williams and Sally Edwards for their prepared remarks. Mikel, please go ahead.

Mikel Williams

Thanks, Kathleen. And I thank all of you for joining us today for a review of our third quarter 2008 results. I'll begin by providing the highlights of the quarter and what we see in the market particularly with news relative to the challenging economic environment out there. I'll then turn the call over to Sally, our CFO, for a review of the financial results in more detail and then I'll then wrap it up with a few additional comments before we open the call up for questions.

The third quarter reflected another solid performance as we continue to focus on the execution of our core strategy. Our third quarter net sales of $49.3 million reflect the strong increase of 14% over the year-ago third quarter. Net sales were down 4% on a sequentially quarterly basis reflecting the softer bookings we experienced in the back half of the second quarter and as was discussed on the last earnings call and as expected.

The PCB bookings for the third quarter were $51.1 million and mark a quarterly record since the company emerged from the financial restructuring in December of 2003. This demonstrates that we are taking market share and when viewed in the context of the full market’s performance our strong bookings performance, I believe, is due to several critical factors. First, over the past several years we have considerably strengthened and extended our sales team and our geographical coverage. And this is a performance-based team. Second, our technology capability together with best-in-class technical support for our customers differentiates DDi in the marketplace. And third, our fundamental execution on our commitments to our customers, both with the operations of our facilities and also in our customer support functions.

In addition to the total bookings during the third quarter, let me add that our pricing was relatively stable after considering the shift we continue to see towards the higher technology requirement. We see more sequential lamination work, more stacked MicroVia, more deep MicroVia as well as other technology as required to facilitate the smaller form factor and higher functionality of today’s electronics products.

As for our strategic initiative of extending our presence in the key military aerospace market segment, again we see continued signs of success. Our sales increased sequentially and year-on-year and for the third quarter comprised approximately 24% of our net sales. With this we remain well diversified with no individual program making up a significant share of the business. Our largest individual military aerospace customer itself is spread across multiple programs and procurement units comprise less than 3.5% of our total bookings in the third quarter. Further in August we received the AS9100 certification for our Virginia facility. Again this is a certification applicable to the aerospace market segment and is yet another example of our commitment to meeting the needs of these customers.

Heading into the fourth quarter, our progress with customers in this market segment is manifest by our growing sales pipeline on specific military aerospace programs. We are confident in our ability to drive further success going forward and believe we are gaining significant ground in deepening our relationship and our position with the military aerospace customers as they rationalize their supply base both now and for the future.

Our third quarter gross margin increased to 20.8% from 17.9% a year ago and was up slightly over the second quarter. This reflects improved unit pricing relative to the product mix shift towards the higher technology products coupled with tighter cost management including both labor and our other input costs. As stated last quarter, we are working with our suppliers to drive costs out of the business wherever possible and we will continue this effort.

Additionally, all year long we have been engaged in a company-wide campaign to reduce all elements of our cost structure particularly factory overhead costs and are now seeing the benefit of these efforts.

The result of all of the above is that we continue to see improvement in the bottom line financial performance of the company. Net income of $1.6 million is the best quarter of the year and slightly up – and significantly up from the year ago quarter. Our balance sheet and liquidity remain in solid financial shape as Sally will discuss in more detail. The work we accomplished in the past years to strengthen our capital structure coupled with the discipline with which we manage the business on a daily basis will serve us well whatever the general economic environment going forward.

We continue to invest in our industry leading technical capability as this is a critical differentiator and essential to our future success. During the third quarter, we spent $3.6 million on capital expenditures bringing our total year-to-date Capex to approximately $9 million.

Last quarter we mentioned several significant projects targeting increased technical capability and capacity expansions in key areas of our facilities. The high-end plating line in our Virginia facility has been installed and will be released to production by mid-November. We are added to our laser capabilities, both imaging and drill systems as well as other equipments to drive our technical roadmap forward. As we have said previously our technical capability underpins our leadership position in the marketplace and is what customers seek in DDi.

Looking to next year and recognizing that we have made significant investments during 2008 we are well positioned to take full advantage and focus on sweating the assets, as we say, based on the equipment we put in place this year We also continue to attract top talent within the industry while at the same time managing up or out our lower performers as a matter of ordinary course. Capability comes not from equipment but mostly from the talent and morale of our employees.

We ended the quarter with 1325 total personnel, down slightly from the end of the second quarter of this year. Going forward, we will be attempting to managing our labor costs in line with the market demand for our services.

In summary, I’m pleased with the third quarter’s performance and look forward to a ramping up in the balance of the year. Let me now turn the call over to Sally Edwards, our CFO, for a review of the quarter’s financials before I close with some final comments.

Sally Edwards

Thanks Mikel. As Mikel stated, consolidated net sales in the third quarter for $49.3 million, an increase of 14% from the prior year's third quarter but a slight sequential increase of 4% from the second quarter ‘08 due to the typically slower summer months. On a year-to-date basis net sales increased 9% to $147.8 million for the first nine months of 2008 compared to $135.9 million for the same period in 2007. Gross margin as a percentage of sales was 20.8% in the third quarter, a significant improvement from 17.9% in the same quarter last year and slightly higher sequentially from 20.3% in the second quarter of ‘08. The year-over-year improvement was primarily a function of the higher sales volumes over Q3 of last year coupled with the operational and cost initiatives Mikel mentioned earlier.

On a sequentially basis, the margin improved slightly even on lower sales volumes due to a couple of factors. As you may recall in the second quarter we noticed some labor and overtime issues we faced related to the quick ramp up of demand early on in the quarter that had negatively impacted our Q2 margins. During Q3 these issues were addressed and our labor costs were more in line with our expectations and we had a slightly higher average pricing related to the mix of products that shipped which also contributed to the slight improvement in margins.

On a year-to-date basis gross margin was 20.5% up from 19.9% in the first three quarters of 2007.

Sales and marketing expenses in the third quarter were $3.2 million or 6.6% of net sales, a slight increase from $3 million or 6.9% of net sales in the third quarter of 2007. The increase in expenses was primarily due to higher compensation costs related to higher sales levels. The reduction in sales and marketing expenses as a percentage of sales is due to the previously mentioned more efficient sales strategy we implemented during 2007 favorably impacted overall commission expense.

On a sequentially basis, sales and marketing expenses were flat at $3.2 million. Year-to-date sales and marketing expenses increased to $9.7 million compared to $9.4 million in 2007 due to higher compensation costs from strengthening our sales team but improved as a percentage of sales to 6.6% compared to 6.9% in the first three quarters of 07, primarily due to the more efficient sales distribution strategy resulting in lower overall commission expense.

General and administrative expenses were flat at $3.5 million for both the third quarter of 2008 and 2007. As a percentage of sales, G&A expenses decreased to 7.1% in the third quarter of 2008 compared to 8% in the third quarter of 2007. While there were several expense categories with cost reductions year-over-year including telecommunication costs, stocks consulting fees, and other consultants, these were offset by higher non-cash compensation related to stock options and equities, depreciation, and higher management incentives.

On a sequential basis, G&A expenses increased to $176,000 from $3.3 million or 6.5% of net sales in the second quarter, primarily due to the timing of our consulting fees heavily concentrated in the third and fourth quarter of the year. Year-to-date G&A expenses decreased $0.5 million to $10.7 million or 7.2% of net sales compared to $11.2 million or 8.2% of net sales in the first three quarters of 2007 primarily due to the expense reductions as previously mentioned and other overhead cost initiatives which were partially offset by higher depreciation and management incentives.

In the third quarter of 2008, adjusted EBITDA was $7.1 million or 14.3% of net sales, a significant improvement over adjusted EBITDA in the third quarter of 2007 of $4.3 million or only 10% of net sales primarily due to the top line sales growth and margin improvement.

On a sequential basis, adjusted EBITDA was down slightly from the second quarter’s adjusted EBITDA of $7.4 million or 14.4% of net sales primarily due to the lower sales volumes and slightly higher G&A costs. Year-to-date adjusted EBITDA increased 33% to $20.5 million or 13.9% of net sales compared to $15.4 million or 11.3% of sales for the first three quarters of 2007.

For the third quarter of 2008, income tax expense was $513,000 compared to a tax benefit of $268,000 in the prior year third quarter primarily due to an increase in US and Canadian taxable income over last year. On a sequential basis tax expense decreased over the second quarter of ’08 of $831,000 due to a change in projected annual income coming from both Canada and the US. Our Canadian effective tax rate is considerably lower than our US effective tax rate due to recognition of Canadian R&D credit. On a year-to-date basis income tax expense was $1.8 million compared to $412,000 in the prior year comparable period. This year-to-date increase was primarily related to an increase in both US and Canadian taxable incomes in 2008 compared to 2007.

Net income for the third quarter of $1.6 million or $0.08 per diluted share improved significantly compared to breakeven or $0.00 per share for the prior year's third quarter.

On a sequentially basis, net income increased slightly over the second quarter net income of $1.5 million or $0.07 per diluted share and was primarily driven by the lower income tax expense. Year-to-date net income improved to $3.8 million or $0.18 per diluted share compared to $1 million or $0.04 per share in the first three quarters of 2007. We ended the third quarter with total cash and cash equivalents of $17.1 million after spending $8.7 million to repurchase 1.6 million shares of our common stock during the quarter. In total, we have now spent $15.3 million in cash to repurchase 2.9 million shares of our stock since the inception of the repurchase program in August 2007. We have had no borrowings outstanding on our line of credit, which had a borrowing capacity of approximately $20 million as of September 30.

Our DSO improved to 55 days at the end of the third quarter, compared to 56 days at the end of last quarter. Compared to last year's third quarter, DSO increased slightly by 1 day from 54 days. With that I would like to turn the call back over to Mikel.

Mikel Williams

Thanks Sally. As we move forward we believe DDi is well positioned both in terms of our financial strength as well as with the sound business strategy and employee culture focused on execution. During the period of softening demand in the commercial sector we anticipate a bias in the supply chain towards inventory reductions and fewer large more predictable orders for printed circuit boards. The results we may see, relatively speaking that is is an increased emphasis on smaller orders needed with shorter delivery schedules which is consistent with our business model and focus. Further, our leading commercial OEM customers we believe will by and large continue with their NPI activities throughout a cycle of lower end-market demand for their current products.

On the military aerospace side, again I am really pleased with our progress and continue to see significant opportunities to expand this business going forward. Lastly and as mentioned on prior calls we are mindful of consolidation opportunities in our base North American marketplace as well as opportunities for an extension of our service offering to include capabilities for high technology and higher volume requirements which are best met from a lower cost region such as Southeast Asia. While such opportunities may become clear in a tougher market all and any opportunity we may consider will be directed towards driving DDi’s shareholder value higher and with a particular attention to the current economic environment and the state of the industry. With that we’re ready to take any questions there may be on our third quarter results or about the condition of the industry and the players. Operator.

Question and Answer Session

Operator

(Operator instructions) Your first question comes from the line of Shawn Hannon from Needham & Company. Please proceed.

Shawn Hannon – Needham & Company

Yes, good evening.

Mikel Williams

Hi Shawn.

Shawn Hannon – Needham & Company

Hi, if there is a way perhaps, Mikel if you could perhaps expand a little bit on some of the trends that you are seeing in terms of what is the complexity of the boards with some of your customers. You know, some of the trends in terms of taking out what have been kind of added programs that has as a result kind of biased the mix versus with your existing customers. Are there some current trends that you are actually seeing taking place there?

Mikel Williams

Are you talking about trends in the technology?

Shawn Hannon – Needham & Company

That is correct.

Mikel Williams

Okay. what is happening out there is the density, I mean in layman’s terms the printed circuit board connects the semiconductor with all the other components and also serves the purpose of providing form factor for a device. It is structured to the device. What is occurring in the printed circuit board community as you may be aware is more dense semiconductors that basically drive a higher density interconnect requirement or HDI as it is referred to in acronym, for the boards and specifically with higher pin counts under the chip. So what that does is it drives the need for the density requirements. It drives the need for increased technical capabilities on behalf of printed circuit board manufacturers such as ourselves. So we’ve seen a significant shift in the OEM community adapting to the new chip sets that are coming out, have been, and will continue to come out, and even to the extent that it is going you’ll know into the military market where they may not be quite as focused on smaller devices like you find in the consumer electronics market, but they really have to embrace these new technologies because the chipsets of the past in effect really won’t be available in the future. So we’re seeing a lot of interest and demand for our capability and in that regard and along those lines given what we have been investing in with respect to our laser technology, laser direct imaging, the laser drilling systems that enables our capabilities to meet the higher density interconnect requirements. We find that is a differentiating kind of feature in a competitive marketplace. Further, we didn’t kind of mention it yet but this process innovation that we have brought to the market and has now been out there for really about a year. I think the year, last year we first presented it to the standards committee at the ICC event up in Chicago in October a year ago. That really has now started to get significant traction for any customer who has a class 3 requirement for HDI and the military aerospace guys usually really play heavily in that area. So all of these trends that we see driving the HDI requirement deeper into the printed circuit board industry are an area that we play well in. I think Shawn, as you know, DDi was the leader and I believe still is the leader in stacked MicroVia, which is a process of allowing for greater density in the boards. As we are comfortable in that space we’ve actually been out educating the OEM community in actually one event. We just had one in Chicago or in Colorado. We just had one in Texas and will have 50, 60 engineers show up from a local community to understand these trends and then to be able to, you know, do their design work inclusive of what is happening in the market. So, we think this is a big deal. We think that the – you read about it all the time with the chips being released, where they have got chips on chips, and chips packaged in groups, clearly driving interconnect requirements for printed circuit boards into the HDI and that is our sweet spot. We have been there all along. We’re continuing to invest in that area. We’re continuing to invest not only in capital but in process innovation and I think what is underpinning our sales success. If I didn’t answer that let me know and I will try and be a little bit more clear.

Shawn Hannon – Needham & Company

No Mikel I think you did, and just if I could pin it down a little bit further. So, I think that those are some broader trends that you have been seeing. Is there anything that would cause you to provide a – has there been any change in that from September as we are now looking now into (inaudible) the kind of get very narrowly focused on the timing right now?

Mikel Williams

I think if you stand back and look at our business in the context of the current environment we had a great quarter in order intake. I think we’re making really excellent progress on our stated initiative to get after the military [ph] aerospace market, and for a variety of reasons we’re having very good success there. The concern I have is what is going on in the commercial space, and frankly in that area we see kind of data spots all over the chart. You know, we have got some customers that have slowed down no doubt. They are concerned about end market demand. They have pulled back a bit. We’ve got other customers all commercially focused not military aerospace, who are busier than can be. As I said in my close – at one point in the comment we think that the sum of our larger OEMs and we say that is because of as a result of our conversations with them. They are going to be spending to bring new products to market whether we go through a down cycle or not. And that is their (inaudible). When the market comes back and it will they have to have their products out there. They can’t put their whole business on hold and so those customers that we help with their NPI efforts are going to stay and have stayed as busy as ever. Of course there are those that we’re going to see feel the downturn and I think that all will probably see some softening in the commercial sector. I don’t have a crystal ball any better than anybody else but when you read the newspaper and you look at the kind of various analysts downgrading the EMS sector generally and some of our peers I can’t help but feel that that is also something that we will feel and see coming into our business. However, I got to tell you I am very excited about our military aerospace efforts and I’ve bought for example, we’ve got the sales team doing some forecasting now and tracking the programs that were engaged with customers on and the volume of items in our sales pipeline has just consistently been growing and it is actually I think in very good form and it could be the basis upon which we continue to do very well even though the commercial sector is going through a down cycle. So I think whether it is foresight or luck that the shift we made in our strategy to embrace the military aerospace sector was right on the money. It is manifesting itself now both in the year-to-date results but also in the pipeline of real activity that we are pursuing as we look forward. It is on that basis that I am pretty optimistic about how DDi will perform even in a tough market.

Shawn Hannon – Needham & Company

That is helpful. If I can just ask a second question here, is it possible if you could maybe share some of your thoughts or views on current capacity in the U.S. and perhaps specifically as it relates to a quick turn or premium boards manufacturing?

Mikel Williams

Yes. Well when we look at quick turn, and I want to be pretty specific, (inaudible) is a good solid competitor and I don’t know enough about their business to speak. Frankly, I will know they will have released next week (inaudible) they are a great group of folks and they do a good job and standard appliance [ph] is I think a very viable competitor for us. (inaudible) as you know about data circuits in San Hose years back as an extension into the quick turn market. So, they have said more publicly that that is what they are going after. If you look at the combination of speed and technology, however, I think that you can quickly cross off a lot of the players and end up I would love to turn this into two horse race with (inaudible) in particular, but you know you have got to spend a lot of money and not just buy the equipment but have the people to bring up the capability and then make it work everyday to deliver in the quick turn market with higher reliability, hide dependability, on the high technology front and that is why I say that is a market that I believe we can do well in and continue to differentiate ourselves.

Shawn Hannon – Needham & Company

Okay, that is terrific. Thanks very much.

Mikel Williams

Thank you for the questions Shawn. Always good to hear you listen in.

Operator

(Operator instructions) The next question comes from the line of Robert McNamara [ph] with Hudson Technology [ph]. Please proceed.

Robert McNamara – Hudson Technology

Mikel.

Mikel Williams

Hi Bob.

Robert McNamara – Hudson Technology

Hi, how are you?

Mikel Williams

Pretty good.

Robert McNamara – Hudson Technology

Hey, a question for you here the margins obviously have been improving both on the gross margin and operating margin line here. I am just curious whether with this additional opportunity in the military aerospace if you see opportunities even in this market to continue to improve the margins or, you know, you sort of topped out here as far as you can go, you know, competitively speaking in the marketplace?

Mikel Williams

Yes that is a good question. And I won’t – let me answer it with a couple of different parts to it. One, I think the margin opportunity is certainly higher in the higher technology arena primarily because when you get into some of the really high-end capabilities the competitive framework and the number of other guys that our customers will want to go to is fewer and so as a result you know we try to seek a fair return for the investment both of capital and effort that is necessary to meet that higher technology requirement and as a matter of fact as I said to all employee call we always have before these earnings calls, we need to continue to do that because if we can get the higher price on the sales order at least then we have a good shot of running the business and improving our operating efficiencies and improving our margins as a result. Obviously mindful about consistently offering good value to our customers. When we look at our cost it is an interesting period now because a year ago everybody was always worried about input costs going up and there was certainly that pressure out there as well. But if you look at the raw material component such as oil, copper, two leading things as you know. Those things have seen some relief in the market obviously and we’re pretty focused on going back to our supply base and making sure that we move our input costs in line with what is going on in the real market out there. And I think we’ve had some pretty good success not in all areas but generally across the board being smarter about how we procure and work and in some cases create win-win situations with our suppliers. So, you know, that is a never ending battle as you know. When you are in this business you are always having to pay attention to all your input costs all the time. But I think that we can do a better job in that area as well and between getting more of the higher technology out there, getting out of the more of the commodity work or standard technology work as well as improving our operating efficiencies including input costs, I think, we can see some margin improvement. You know, as we look at that it is significantly impacted by how we – what kind of capacity utilization we are running at and if the overall market slows down it makes it tougher and yet we will see where the market takes us.

Robert McNamara – Hudson Technology

Thank you.

Operator

Your next question comes from the line of Matt Riegner [ph] with Randac Funds [ph]. Please proceed.

Matt Riegner – Randac Funds

Hi, Mikel how are you?

Mikel Williams

Good.

Matt Riegner – Randac Funds

On the competitive side any big changes there with this weakening in the environment or anyone going under or is there any opportunity there?

Mikel Williams

Yes, how do I address this? You know the US market used to have plus or minus 2000 players and it has shaken out over the years to under 500. I offer that what will happen is that we will see continued shakeout for a couple of reasons, one, if the demand does soften as we believe it is happening and I think it might happen for others more than ourselves. So, we hope the reason we’re focused on making sure that happens that I think some of these guys who have been marginal and still in the game will find it tougher and go away. Secondarily, the vast majority of the players in this space are small single facility privately held, entrepreneurially-owned businesses and those businesses are going to find it increasingly difficult to put a million dollars in for a laser drill system or a million dollars in for a laser imaging system inclusive of the equipment itself then also you have got to build out the facility space in square foot [ph] and have it in the right environment. So, you know, it will be more and more difficult as time goes on for these – I think a large number maybe not the vast majority of these smaller players in the space invest in their business as we are doing and continue to get the benefit out of it from the customers. So I think we’ll see continued shake out certainly at the lower end of the space. When you look at the major players as I’ve spoken to on the prior call I think there is the opportunity to see some rational consolidation out there and, you know, at the end of the day folks need to be acting in the interest of their shareholders not in the interest of the management or the board for fear that they forget who they work for. And when you see opportunities to do things that are in the right interest of their shareholders, hopefully people will come around to that. And as that happens and I think if the market makes it tougher as a go alone strategy for some players that should happen and I think we will see some consolidation among some of the bigger players out there.

Matt Riegner – Randac Funds

And then Mikel going on that what is your view on excess cash right now are you feeling like you need to build a cushion or are you still looking at repurchasing?

Mikel Williams

Well, Matt as you know, we have been buying back stock obviously and in hindsight we wish we were buying as $3.80 or so instead of where was it in time we were in the market. We think it is a great deal right now. I wish everybody who has invested in common stocks out there was paying attention because I think as we were looking at the last twelve months adjusted EBITDA I think it is a multiple somewhere in the range of 2.5, which is – it’ll be different if we were a business that I didn’t think have in place kind of the fundamentals, but I look at the valuation and it is certainly something that we will be looking at vis-à-vis our cash balance. We pretty much run through the share allotment that we approved at the board level previously. We will talk about it on a continual basis and look at our options. Certainly more than here therefore we have an additional interest in ensuring liquidity given the economic environment, but I don’t want to ever sit on excess liquidity beyond what we reasonably need to secure the viability of the business and miss an opportunity in the market. But that is something that we will continually monitor at the board level and make appropriate decisions as we see fit going forward. Certainly recognized, we have demonstrated the interest and ability to pay attention to that issue.

Matt Riegner – Randac Funds

Okay, and the last one was just a little housekeeping question, here the amortization in ’09, is it roughly a $4 million of that is going to fall off in ’09?

Sally Edwards

It will be 190 a quarter.

Matt Riegner – Randac Funds

$190,000 a quarter.

Mikel Williams

Will remain going forward.

Sally Edwards

And will remain going forward. Everyone else will probably will go away in December.

Mikel Williams

About $1.1 [ph].

Matt Riegner – Randac Funds

Okay, so about $1.1 a quarter goes away.

Mikel Williams

Yes.

Matt Riegner – Randac Funds

Okay, great that is what I thought. All right nice quarter.

Mikel Williams

Thank you.

Matt Riegner – Randac Funds

Thanks.

Operator

(Operator instructions) Your next question comes from the line of Shawn Harrison with Longbow Research. Please proceed.

Shawn Harrison – Longbow Research

Hi, good evening. Just three quick questions. I think you alluded to this in some of your answers already but the raw material environment it sounds like you are working with your suppliers, but are you actually seeing the cost of laminates and chemicals come in for you or is that something that maybe you know a future benefit?

Mikel Williams

I don’t want to speak to any one particular supplier but we have seen examples of minor increases. We have seen examples where we have held and not accepted and then eventually got concurrence with no increase and we have seen instances with actual reductions, okay. And so it is hard to overgeneralize other than to say that the increases that we have seen we do not believe are significant, certainly relative to our concerns in prior periods and we see more downside opportunity going forward primarily because we know the kind of the raw ingredients of laminate, oil, resin systems, and copper in particular has eased in the commodity markets. So, you know we will see where it goes. I do know it is probably, I am guessing now and I don’t want to answer for a laminate provider, you got to be calling them I guess, but I do know that if the demand falls off certainly the last thing they like to attach to that is also a price reduction for the guys who are still out there buying. So it is from a negotiating perspective it is certainly a pretty tough market, but we have got great relationships with our laminate suppliers and, you know, they understand that we are business and a customer that they need to stay connected to going forward and that we are going to be one of the folks around. So that certainly helps our position.

Shawn Harrison – Longbow Research

Okay the second question has to deal with just getting back to that competitive environment with some of the unevenness you are saying maybe with your commercial customers. Are you seeing price competitiveness step up here in the December quarter or is that yet not to occur?

Mikel Williams

Well, as I said the pricing was relatively stable, actually up slightly but you have to adjust it the mix in the technology the shift in higher technologies that really we have just seeing – we have seen on a consistent basis. So, generally I would characterize it fairly as steady. We do worry that if the market does soften that we will see additional downward pressure on our pricing. Usually it is not uncommon and we joke in the industry the pricing is set by the next guy going out of business. We are certainly not going out of business and you know we have never defined our value proposition to our customers first and foremost as a lower priced opportunity and we hope that our customers see the aggregate value in dealing with DDi as we offer design support, the design for manufacturability support, all sorts of additional features off our collective package but we don’t price it in other than it is just the price of buying the product from us. So, we are I hope effective in reminding our customers about the aggregate value proposition that we provide. You know having said that certainly on some customers and some products we will probably see some more pricing pressure than others. I think to counter that we’re seeing something that is interesting and that is the military aerospace guys generally I’m not going to overgeneralize, I don’t think it’s suits the picture. Our concern about the quality of the North American supply base. Certainly when it comes to the ability to deliver high technology in a reliable and predictable manner and along with that (inaudible) I mention this all the time, I give them what I call my Jerry McGuire speech. Help me help you. Meaning if they bring more spend to us and we can get more efficient and they rationalize their supply base down to what might be the stronger of the remaining that will really survive these up and down cycles in the industry that everybody goes through then they get value out of it, because I can effectively offer price points because I have the got the utilization of the leverage over my fixed asset base and that resonates well with them. So, you know even if we see some pressure in that regard on the pricing I think that if we can aggregate spend and continue to get kind of leverage over our fixed cost model that is a win-win situation for both us and our customers. Certainly, we have a lot of customers in the commercial spaces where we traditionally have played. It is where our brand value is kind of known to be and that is I need it in a hurry, it is a tough board. I got to go to DDi because nobody else wants to take it on or they are the only ones that I can count on to get it done and meet my requirements. That we find is usually the least price sensitive kind of market that we play and if you will and really that is where I want our commercial focus to be. We are not – as I said before we are not in the North American volume business. We do not have – an interesting statistic, 75% of the orders that we take in require ten panels or less of manufacturing capability to meet the finished requirements. We may release more if our yields are of a certain level that maybe would require that but that industry in and itself tells more about the profile of our business than I think anything else I could speak to. And it is certainly different than all three of my major North American peers each of which who had a large hundreds of thousands of square feet facility that they have got to feed during tough economic cycles. So when it comes to pricing we really try to differentiate ourselves with a complete value of our offerings and we also try to stay out of the commodity board space.

Shawn Harrison – Longbow Research

And then just a final question on the military aerospace market, it sounds like you are taking significant share within that market, but are you also seeing underlying market growth currently as you look into 2009 that would benefit you as well or would your growth in that market mainly come from share gains and kind of consolidations with customers?

Mikel Williams

Well, if you want to talk about the total market I’m probably not the best guy talk to on that because it gets into things that I’m not very good at predicting like what may be the results of the election and given that what the environment brings to our government regardless of who wins the election et cetera, et cetera. I could argue that if the whole world figures out how to happily get along with one another then eventually that is going to not be good for the aggregate military expense. If we have an event maybe (inaudible) pretty soon and maybe that means our military spend is unimpacted regardless of who wins. I want to just make sure it is clear, I don’t know the macro issues any better than you or anybody else. Having said that when we get deeper into these relationships and I go to a lot of them myself. I’ve met with these guys myself, I talk to them. I almost inevitably walk out of the meeting very frustrated that we are not getting what I deem our fair share of their spend and I say that because there is an opportunity for us to grow and I think grow significantly whether the aggregate market grows or not. Having said that again a good number of the folks that we’re working with have programs that are just getting started on a growth path in many respects. Again for example, and I don’t have the customer clearance to mention their names and their products, so I won’t. But one of the ones that has been very successful for us this year where we have been helping a deal (inaudible) customer with their requirements. As now as I understand it gained approval to sell that product to a lot of the foreign governments who are friendly with the US because it is a very successful product. So, it that happens where we have been told we should see a significant lift in the volume of their requirements as they meet contracts with not just the US Department of Defense but the UK, a lot of our other allies around the globe. And so, I think there is significant upside for us to play in that space not just to gain share but then to continue to grow with them as they grow. And if you think about the area we play in, we play in the DOD demand related to technology. And the one thing I have learnt by kind of doing a lot of research on the web and following up on releases of our customers and things, I do believe that the defense industry will continue to spend disproportionately more on technology as we seek to man our warfare or our defense systems with technology as opposed to human capital. And if you look at the programs we are dialing ourselves in on I think they’re going to be there in the defense side regardless of whether or not we’re launching missiles or bombs or something like that.

Shawn Harrison – Longbow Research

Thanks for the insight and congratulations on the quarter.

Mikel Williams

Thank you.

Operator

Our next question comes from the line of Michael Bertz with Kennedy Capital. Please proceed.

Michael Bertz – Kennedy Capital

Thanks very much. Good afternoon and congratulations on the quarter again. I jumped on a little bit late, so I don’t know if you (inaudible) but can you give any colors to current spurts and where things are at and any pushes and pulls, particularly on the commercial side you talked about some concerns about that versus maybe the military, industry, or aero but anything more detailed about them?

Mikel Williams

Yes, in terms of the kind of commercial performance by –

Michael Bertz – Kennedy Capital

Exactly.

Mikel Williams

I’m somewhat guarded to – I will answer but before I do let me kind of just give you a caution that is I worry that sometimes people follow us back because they ant to see it as a leading indicator for how another company or another industry segment may be doing because if they fall off with us they are probably going to then shortly thereafter fall off in other areas of their own business and for that reason I hate to kind of give information about what may or may not be happening in our customers. But I will give you a couple of anecdotes. We have got, I think a very strong presence with presence of the major semiconductor guys, one of which has who has gone through some cycles. I think they have been design related and right now we’re doing okay with. Another one is actually booming and another one we are continuing to grow our share with and so it is kind of hard to tell how they are doing in total but we continue to do well. So the data points are somewhat all over. If I look at some players in the test equipment sector. I think that is going to slow down a bit. And because if you follow the kind of macro in that space all those guys have already come out and said that and so we expect that that will continue to fall off a bit. But you know it is a really hard. Generally what we have seen in terms of the macro inputs of our businesses we see increasingly larger share of our business come out of this military aerospace market segment. And then the rest of them kind of up and down but nothing necessarily to be meaningful for you guys to be predicting it for the balance of the quarter or maybe another industry.

Michael Bertz – Kennedy Capital

Okay, that is fine. I am actually frankly primarily interested as it pertains to you guys, when I look at the overall split, you talked about at least the last I have seen being fairly sizeable for telecom, computing, and automobile industrial and clearly automotive is struggling more than most right now and I would think that perhaps seeing a few, maybe not. So, I am just trying to think about if I look at those major chunks to get more on the commercial side then on the steadier side, are you seeing something where you know you think that maybe your mix is going to change markedly or maybe you are not seeing it because both for technology reasons or for development purposes?

Mikel Williams

Let me kind of address that because you mentioned the auto sector in particular. And we actually started the first, the reason we break that out and we kind of always included in it the kind of the industry auto but in the third quarter we had $230,000 of auto-related shipments which actually surprising. I don’t think we had any. We had never been a company with exposure to the automotive sector and I don’t see that that will change going forward. I would love to have some business out of them if it makes sense but they are not a target market that we are pursuing. The communications obviously in terms of percentage of our mix is down a little bit as they all are given the increase in the military aerospace. The computer group is down a little bit maybe more than the communications and then the rest of them industrial and electronics about flat. The government is really, I mentioned has had the biggest increase. Industrial and medical is about flat but I think going forward in the fourth quarter that is one that has little bit more concern than otherwise I would like to be.

Michael Bertz – Kennedy Capital

Okay, and then finally as you think about 2009 and as you think about sort of your overall mix, clearly you are seeing strength on the steadier side, then would you think that mix would tend to sort of continue tilting in that direction over the course of the year?

Mikel Williams

I hope it does and I hope it does not because the commercial market is softening and the military is not, but rather that the military grows by faster clips than what we would be experiencing in these markets in the commercial sector. You know, I think that if I look at the size of that market and I have estimated to be anywhere from $700 to $900 million. I think we could take – continue to take share and end up with that getting close to in the near term only because of the softness on the commercial side maybe to half and half, and still you know we would have room to continue to grow in that $900 million market.

Michael Bertz – Kennedy Capital

Okay, and last question, I think you talked about wanting to have a certain level of cash to work with and too much excess, where do you feel comfortable with that? Where would you want your cash to be?

Mikel Williams

I don’t have an answer to. Right now I say where we are given what I see right now we are very comfortable, but you know I don’t know how to read the key leads on where the market is going. I wish I had a business where we have a lot of backlog to add stability so that we could be thinner on our cash position and still have good confidence so that it wouldn’t affect kind of any of our go forward plans and be aggressively taking advantage of this low stock price. I would love to be doing that. I think it is good for all of our remaining shareholders but I have a stronger bias towards being very conservative preserving sufficient liquidity both for what we see now and potentially it is getting a little softer out there should that happen.

Michael Bertz – Kennedy Capital

Great. Thanks very much guys.

Mikel Williams

Thank you.

Operator

At this time there are no additional questions in the queue. I would like to turn the call back over to Mr. Mikel Williams for any closing remarks. Please proceed sir.

Mikel Williams

Okay. Thank you operator and thanks again to everybody for participating on the call. I have to have that we really do enjoy having some questions. I know it is a crazy capital market out there and it takes time away from other releases. I’m sure you would like to listen in on and understand and in today’s market there are lots of opportunities out there. I think DDi is a great opportunity for the investors out there in the other end of the phone. Again thanks for taking the time and participating. Thank you for the questions. We appreciate it on this end and we look forward to speaking with your after again after our year-end.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: DDi Corp. Q3 2008 Earnings Call Transcript
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